Although many investors have feared that global growth would slide back into negative territory (i.e. the ‘dreaded’ double-dip recession), the evidence in the chart doesn’t suggest anything nearly as dire.  With consumer spending still growing strongly outside of North America and the continued stimulus from low interest rates, we expect that growth will continue to be positive.  Adding to our positive longer-term outlook on stocks is that they are still under-valued versus the long-term trend on an earnings basis.  The chart below shows the Price-Earnings Ratio for global stocks on a trend basis (i.e. trend earnings would be earnings estimates adjusted to reflect long-term economic growth and are also referred to as ‘normalized earnings’).  Although the P-E ratio spiked to unsustainable levels during the ‘heady’ real estate market of the late 1980s as well as the technology bubble a decade later, the ratio has averaged around 17.1 times over the past 40 years.  The ratio dropped to under 10 times at the market lows in early 2009 but has since recovered.  At only 14.1 times, it remains below the long-term average at a time when earnings are still growing.  Reasonably priced stocks and improving earnings support our more bullish longer-term view on the overall stock market.

The bigger question now is deciding which sectors have the best ability to generate the best returns going forward based on historical valuations as well as earnings growth rates.  We still see the commodity sector being one of the best areas for gains over the next 5-10 year period as the industrialization of the emerging markets of the world keeps on its current pace.  Supply constraints are also an issue as new supplies have failed to grow at the rate of demand, leading to shrinking inventories and rising prices.  The base metal markets (particularly copper) look particularly good as do many of the bulk materials such as iron ore, metallurgical coal and specialty metals.   Grains, fertilizers and a variety of other ‘soft’ commodities are also in the same ‘growing demand/constricted supplies’ syndrome that should keep markets relatively firm over longer term periods.  But, as mentioned earlier, many of these commodities, and particularly gold, silver and oil, have seen significant financial market buying recently as a play on a falling US dollar.  This could create some short-term headwinds for the resource sector.  Technology stocks, however, continue to benefit from global growth which has been focused on high tech consumer goods.  Valuations in the tech sector are also more attractive than they have been in a long time.  US names dominate our top choices here.  Apple Inc continues to be the leader in innovation with the iPod, the iPhone and now the iPad, which seems to be leading to a major shake-up in the personal computer business overall.  We also believe that the ‘death of the Blackberry’ has been way over-exaggerated in the price action on the stock of Research in Motion. RIM still dominates the business (enterprise) market and has a much stronger global profile and stronger carriers relationships than its main competitors and is trading at an absurdly low level of about 8 times forward earnings.  IBM has transitioned extremely well from the hardware business to the services end which gives it more consistent earnings as well as a stronger recurring business.  Cisco continues to dominate the communications equipment business which, although not growing at nearly the rate of a decade ago, is still expanding and maintaining strong profit margins. Though Intel and Hewlett Packard face some more competition issues and somewhat higher risk as the computing environment moves away from laptops, notebook and desktop computers to PDAs, tablets and ‘cloud computing,’ the companies are still the dominant players in their respective fields, have large cash balances and are growing earnings.  Finally in this sector, Microsoft remains a name of interest to us.  It has certainly suffered from competitive pressures over the last number of years as it has lost market share in search, browsing and even software development.   But it has also continued to adapt, bring on new products and generate strong returns which have built up its cash position.  It also has a unique position as an online software services vendor in the growing area of cloud computing that many corporations are shifting to.  Moreover, all of this comes with a strong balance sheet, great cash generation and a valuation well below the overall market.  That is the common theme with all these stocks though.  They are trading at earnings multiples in the 8-12 range, which is about as cheap as they have ever been and extremely under-valued for companies that operate on a global basis, generate strong cash flows and have high gross margins.

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